WALL STREET WATCH

SBC's growth drive not without its hazards

Once the tiniest of the Baby Bells, the San Antonio-based telecommunications firm has already gobbled up two of its former brethren and is in the process of acquiring its old parent company.

After picking up Pacific Telesis and Ameritech, SBC's latest acquisition, the $16 billion stock and cash deal for AT&T Corp., is a bet on economies of scale. SBC aims to sell all sorts of new wireless services to the former icon's corporate customers.

But SBC shareholders have been lukewarm about the AT&T deal, not to mention the company's overall growth strategy. SBC's stock is down since the company announced the AT&T acquisition in January and off nearly 13 percent this year.

Robert F. Bruner, dean of the University of Virginia's Darden Business School and author of "Deals from Hell," a critique of large mergers, sees limits to how much earnings SBC can get out of AT&T.

"In the most optimistic scenario, there's the sheer complexity of knitting together two very complex operations," he said. "In the worst case, SBC may simply be acquiring a very expensive customer list."

For SBC, though, the AT&T deal is just one factor contributing to shareholder uncertainty.

Like its closest peer, Verizon Communications, the former Southwestern Bell survived the late-1990s telecom wars but is under pressure to navigate the modern-day convergence of television, telephone, wireless devices and the Internet.

The big telecommunications companies would like to sell you all those services in one "bundle," in part because their core business, landlines, is eroding at a pace of 4 percent to 5 percent a year, says David Janazzo, Merrill Lynch's telecom analyst.

The Bells have staked their future in two areas: wireless and broadband-to-the-home. SBC and Verizon, though, are taking different paths.

On wireless, SBC and cell phone partner BellSouth Corp., co-owners of Cingular Wireless, are trudging through the formidable task of merging last year's all-cash $41 billion AT&T Wireless acquisition with Cingular's existing network while simultaneously transitioning the whole thing to a third-generation, or 3G, format.

The move to 3G--a very high-speed wireless network--is essential to capture the so-called "enterprise customer," the business traveler who wants fast access to data and video.

But Janazzo says Cingular's 3G deployment is at least a year behind Verizon Wireless, so AT&T's clients could be tempted to leave SBC for its chief rival.

"SBC and BellSouth knew that going in, and we've pointed out many times the potential for delays," said Janazzo, who has a "neutral" rating on SBC.

The other half of SBC's growth strategy, shared by Verizon and other telecoms, is to take over the television from their cable-TV rivals.

SBC has bet on IPTV, or Internet protocol television, a strategy that uses the old copper cable to go directly into the home.

The company plans to spend about $4 billion to $5 billion through mid-2008 for a technology that still has some kinks and won't offer as much broadband as Verizon's planned fiber-to-the-home service. Of course, Verizon's decision to spend $15 billion through 2010 has it shareholders running for cover: Its stock is down 26 percent for the year.

SBC Chief Financial Officer Rick Lindner counters that IPTV will provide more than enough broadband and will bring video service to more of its markets sooner than Verizon.

"This is significantly less expensive, and we've preserved the option to run fiber the rest of the way," Lindner said. "Plus, we don't have to dig up a lot of streets and flower beds."

Investors, Lindner said, remain too focused on newfangled technologies and Internet stocks. Wireline revenues, he said, are up for five consecutive quarters. The pace of DSL additions versus landline losses will be a hot topic when the company reports its third-quarter earnings Thursday.

Ultimately, the future of telecom stocks depends on "bundling." But historically, Janazzo says, the Bells have not done a great job of packaging their various services.

"You still have all sorts of structural hurdles which will have to be overcome if they are to successfully market bundled services to enterprises," Janazzo said.